Amit Rathore's blog about software and startups

Tag: fund-raising

I’ve been researching early-stage financings. I know I’ll soon be talking to investors, so I figured I’d better understand what the various options are and what they mean. I also thought I’d share my research with others, and so if you’re in the same boat as I am, then perhaps this post on the evils of convertible notes will help you 🙂

Before I started researching this topic, I always thought convertible notes were a great way to raise your first round of outside money. The benefits were touted by everyone who were supposed to be in the know:

they’re faster to get done

they’re cheaper to get done

they’re easier to get done (term-sheets are simpler)

they delay the pricing question so you have time and money to build out your company a fair bit before a price is set on it. That’s obviously in your best interest, since your company probably isn’t worth very much when you just start out

everyone is happy, and there are no real downsides to this type of financing

Here’s what I believe now:

it isn’t fair to the very people who take the most risk and believe in you before any one else did. Why? Because, the better your company does, the higher the price they pay for their shares. That just isn’t the right way to treat your earliest backers and well-wishers.

this situation is why most convertibles now have valuation caps on them. So if you’ve raise 2M with a 8M pre cap, you expect to give away at most 20% of your company. And you’re probably cool with that, in fact, the higher the cap, the better, eh? But a cap is not a (minimum) valuation, so what if you later find that you can only find investors at a price of 4M pre? You’d have given away 33% of your company to those initial investors. Maybe that’s OK, but you no longer have a choice in this decision

convertible notes also have a discount associated with them, so in the above scenario, if that discount was 25%, you’d actually have to give away 40% of your company, when you were only ready for 20%. Again, if you thought this was OK to begin with, maybe you’d be OK with it, but you’d no longer have any control on this decision either

These are the reasons that, as an entrepreneur, a convertible debt round is rather bad.

More than the financial reasons, though, my problem is with the misalignment of interests. I’m a very firm believer in partnerships. You want your interests perfectly aligned with your investors. Right? With a convertible round however, even though they wish you success, your investors would rationally hope for a lower price for your company, so their investment works out better. They’d want you to succeed, but not too much. They’d want you to succeed just enough to be able to raise a series A, and then succeed a lot more later. That isn’t aligned.

The color of all money is green, but you get a lot more from your investors than money. And this misalignment screws that up.

Even if it all works out in your favor, I really hate how it isn’t fair to your early investors. These folks took the highest risk, believing in your dreams and capabilities. Punishing them with higher prices isn’t what partnership is about.

So I now think it makes more sense to raise a priced round at a decent valuation. That’s what we’ll look for when we start looking for Zolo Labs.

P. S. – I’m obviously no expert in any of this, and am just getting started on learning about it. So take everything here with several huge grains of salt. Perhaps another thing is that if you’re a super-hot startup and everyone (knowingly) wants to get in, then I imagine it changes this model of thinking…

Editor’s note:Cherian Thomas is founder and CEO of Cucumbertown, a recipe-publishing platform. Follow him on his blog and Twitter.

For entrepreneurs, it is now both easier and harder to raise capital: easier because of powerful platforms like AngelList; harder if you’re not part of an accelerator or don’t have a strong network.

Silicon Valley has more startups than ever before. My startup, Cucumbertown, raised its first round a month ago, and during the course of this journey, I realized that, as a first-time entrepreneur without any solid Valley footing, my run toward raising funds as a non-American co-founder was somewhat unique.

Valley funding used to be an impenetrable fortress that opened up only by way of introductions. Your success in raising capital decreased to insignificant levels otherwise. The only other chance to make yourself noticeable was traction, which trumps everything. But the market dynamics of fundraising is shifting, and investors are no longer clustered in the Valley. Accelerators are becoming the showcase for promising startups. I was initially disappointed when a VC told me their firm only focuses on YC companies. But then I realized it makes more sense for them to look at YC, 500Startups or TechStars than to sift through hundreds of decks. These accelerators are becoming the entrance exams for selection.

So here’s how my month of experience as a non-accelerator, non-American fundraiser translates into advice.

Make Friends Fast

I was scheduled to meet 500Startups Partner Paul Singh on the second day of fundraising. As I waited for my appointment, Courtney Powell, CEO of PublikDemand, asked me about Cucumbertown. We became friends within the hour. The PublikDemand team invited me to crash at their home and Courtney taught me everything she knew about fundraising. We continue to meet whenever I am in the Bay Area. Courtney even re-wrote my press release notes.

After I read Darius Monsef’s article on TechCrunch, I contacted him, and he put me in touch with Rajiv Bhat, co-founder of YC alumni Mertado. Rajiv advised me on everything from convertible caps to living life as an Indian founder in the Valley. Nowadays Rajiv and I meet frequently here in Bangalore to track one another’s progress. I even bake for him.

Cucumbertown’s first investor and the co-creator of Farmville was Sizhao Yang, and we became great friends. He also offered constructive criticism of Cucumbertown. Every now and then Zao mails me one-liners reflecting something on the industry worth understanding. Zao now is my 1 a.m. friend/investor on call.

Cucumbertown’s most important advisor and friend is Naval Ravikant. He responds to every email and takes action when necessary. He even follows up. When Naval said stop, I stopped. When he asked me to meet him at AngelList HQ in San Francisco, I changed all my other plans.

These people represent only a fraction of the relationships I built in less than a month, and they represent the change in Cucumbertown’s trajectory to success.

Meet With Companies Who Have Raised

It’s also important to meet with companies who have recently raised. They have a wealth of tribal knowledge that can help you save time. For instance, I met with a company that closed its funds in October, and they advised me about the shift in investors’ herding mentality due to the September YC Demo day this year. This was a wealth of information, as I was able to strike a number of investors from my potential list.

Get On AngelList

AngelList is powering the Valley’s revolution in investing and raising funds. During one of my lunches with an investor, he said that raising funds for the first company he co-founded was near impossible. And raising series A was much more difficult than that. His company’s investors played waiting games and did not introduce the company until their contacts came into the picture. He said shady acts like this frustrated him as an entrepreneur.

AngelList changes all of that and is perhaps the most important tool you’ll need as an entrepreneur raising capital. It is the canonical source of all things related to angel funding in technology now. Never has Silicon Valley been in a position where every investor and fundraiser could e-meet at a platform.

Cucumbertown represents a first-time investment for Mokriya‘s CEO Sunil Kanderi and partner Chandra Kalle. I met them during a growth hacking conference in San Francisco, and they expressed their desire to be connected to Cucumbertown. Our profile on AngelList, our existing investor list there, and our testimonials offered the credibility we needed to gain their trust. And investor Stefano Bernadi followed us out of the blue on AngelList and subsequently invested in Cucumbertown.

Here are some things I learned to be successful on AngelList:

Build a concise and compelling profile.

Make it equally good for your team, too.

Follow investors early on, even during your idea incubation stage, to understand their modus operandi.

Follow partners at VC firms to understand the deals they are seeking. You can view their activity stream.

When you get your breakthrough investors, immediately connect with their connections and start the conversations (AngelList allows you to talk to connections of connections).

Showcase your strengths in the status messages. Don’t overdo it.

Respond to everyone who initiates a message with you. But once you start calendaring in people become selective in appointments.

Get your investors to write testimonials for you.

Almost every company listed there is exceptional. Being different is difficult. But seek the difference.

Silicon Valley works largely by clustered investments. Your company would have always had a chance of being invested in by people who knew each other. And limited by them, too. That has changed with AngelList.

Calendar Every Meeting

I met 28 investors/funds over three weeks, and more were scheduled. The Valley is flooded with investors, and it can get pretty overwhelming once people start responding. Keep it organized and calendar all meetings. The executive assistants for most of these investors will reschedule your meeting at least three times. You have only once chance, so be prepared to move around.

Learn To Say No

As tempting as it was to accept capital from anyone — especially with the uncertainty of the future looming over our heads — we said no to investors who did not align with our thought process and principles. It was difficult. But we sleep well today. My new best friends in the Valley taught me this quality, as well.

Maintain Heat

The Valley has more startups now than ever before, and investors are bombarded by a hundred pitches every week. You are as valuable to them as the other 99 and so are likely to get lost within three days. Be proactive in the conversation, and try to get a response in a week.

Fundraising is a game. If you know you have a good product/team/traction, then get in to win. You are already here because you believe in something. Continue the journey to win. Persevere.

Thanks to Maneesh Arora, advisor and investor in Cucumbertown, for the draft review.

[Disclaimer: 500 Startups is an investor in Cucumbertown. But we are a non-accelerator investment. Though Naval is AngelList’s co-founder Cucumbertown did not benefit any special status. Cucumbertown wasn’t a featured startup or did not show up in the trending list. Dan Hauk is Cucumbertown’s American co-founder. But Dan was not involved in fundraising. Cucumbertown is a distributed startup and none of us co-founders have seen each other. I travelled to the Bay Area to raise funds.]

I’ve been away a long, long time. In fact, I thought I was done with this blog. I had even moved onto a different blog (s-expressions), which of course, lies fallow these days… sigh.

So, for the past year or so, I’ve been stepping away from day-to-day coding at my current job at Runa. I’ve been getting involved in more and more of the business side of things as the VP of Engineering. And thanks to that, I’ve really learned a lot more. I wanted to write about some of that, so I figured I’d revive this old blog… so here goes. BTW, today’s post isn’t about Runa 🙂

Just finished reading Venture Deals, by Brad Feld and JasonMendelson, and it’s a great introduction to the basics of the VC industry. I’m finally beginning to understand things like liquidation preferences, pay-to-play, employee stock-option pools, anti dilution, and a lot more. Not only is the content great, but the style of writing is very readable… highly recommended!